On October 1, 2010, the Ontario Superior Court of Justice rendered a decision in the matter of Jeffrey and Rudd v. London Life Insurance et al.1 In this class action,2 the plaintiffs alleged that the acquisition of London Insurance Group (LIG) by the Great-West Life Assurance Company (GWL) involved a number of breaches of the Canadian Insurance Companies Act (ICA).3
The decision is of interest as it results from one of the very few common issues trials conducted under s. 11(1)(a) of the Class Proceedings Act, 1992 (CPA).4 Moreover, the case is particularly noteworthy given that, on the basis of the common issues trial alone, the Court made an award totaling $455.7 million against the defendants. The defendants have announced their intention to appeal the decision.
The class proceeding arose out of the 1997 acquisition of LIG by GWL and its parent, Great-West Lifeco Inc. (GW Lifeco), for $2.9 billion. LIG is the parent company of the London Life Insurance Company (LL).
The fundamental dispute between the parties related to the fact that the acquisition price had been partially funded by the participating policy accounts of both GWL and LL. Under the ICA, a participating policy is defined as an insurance policy that entitles the holder to participate in the profits of the company. For this added benefit, participating policyholders pay premiums that are generally two to three times greater than those paid for non-participating policies. The ICA thoroughly regulates the operation of these policies. For example, the ICA mandates that insurance companies keep separate accounts for participating and non-participating policies;6 requires that income and expenses be allocated across participating and non-participating accounts pursuant to previously approved allocation methods;6 and limits the manner and extent to which dividends, bonuses or other benefits may be paid out to participating policyholders.7
In the lead up to the 1997 acquisition, GWL was concerned that the GWL and LL participating accounts would benefit from the merger synergies of the transaction without paying any of their cost. To avoid this perceived windfall, through participating policy account transactions (the PATs), both the GWL and LL participating accounts were tapped in order to fund a portion of the purchase price.
Specifically, prior to the acquisition, $40 million was transferred from GWL's participating account to its non-participating or “shareholder” account. A further $180 million was transferred from the LL participating account to the LL shareholder account. Through a vendor take-back mortgage, this $180 million was then loaned by the LL shareholder account to the GWL shareholder account. In total, then, $220 million was transferred from the GWL and LL participating accounts and used by GWL to fund approximately 7.5 percent of the $2.9 billion purchase price.
In return, the GWL and LL participating accounts were granted “prepaid expense assets” (PPEAs) in amounts equal to their contributions. The PPEAs were intended to represent the future expense savings from the merger synergies, and were to be amortized annually as an expense of the participating accounts over 25 years.
Thereafter, the plaintiffs, being participating policyholders of GWL and LL, initiated a class proceeding against GWL, GW Lifeco and LL, alleging unjust enrichment and a number of statutory breaches in relation to the PATs.
At the common issues trial, there were essentially four groups of common issues that were dealt with by the Court: (1) allegations of statutory breaches by the defendants; (2) allegations of statutory breaches by the directors and officers of the defendants; (3) allegations that GWL and GW Lifeco were unjustly enriched through the acquisition; and (4) issues as to the remedies available to the plaintiffs if any of the previous allegations were proved.
Following a 45-day trial, the Court found that the plaintiffs had proved that the defendants breached three separate sections of the ICA, and that the directors and officers of the defendants breached a further section of the ICA.8
Centrally, the Court found that the defendants had breached section 462 of the ICA, which prohibits “transfers” from participating accounts.9 The defendants had argued that the Court should defer to the Office of the Superintendent of Financial Institutions (OSFI), which had approved the acquisition structure. However, as discussed further below, an OSFI representative was called to testify regarding the regulatory body's review of the proposed acquisition and admitted that, in granting its approval, OSFI had simply relied on an Independent Actuary Report prepared for the defendants prior to the acquisition.
The Court went on to review the Report, and pointed out a number of issues with its preparation. Most notably, the drafter of the Report had initially suggested that a legal opinion be obtained regarding the legitimacy of the PATs, but this was not done. There was also no explanation as to how the drafter of the Report had subsequently become satisfied with the legality of the PATs. Further, there was evidence that the CEO of GWL had made changes to the Report without the approval of the drafter, thereby impairing its independence.
As a result, and given OSFI's failure to critically evaluate the Report, the Court concluded that “the legal concept of deference to a review by an expert regulator does not, in my opinion, apply where, as here, the regulator invites the Court to make its own determination. […] OSFI's process was not an adjudicative one.”10
The defendants had also argued that the PATs should not be held to constitute “transfers” under section 462, as the amounts extracted from the participating accounts were exchanged for PPEAs of the same amount. The Court swept this argument aside, noting that a “transfer” cannot be read to refer to net transfers only, as such a restriction could easily be circumvented by exchanging any surplus in a participating account with a promissory note. Moreover, the Court held that section 462 should be interpreted in light of section 456, which mandates a separation of participating and non-participating accounts. The Court therefore concluded that the defendants had breached section 462.
The Court also found a breach of section 331(4), which requires that all financial statements for companies governed by the ICA be prepared in accordance with generally accepted accounting principles (GAAP). The essential issue here was that, in order to be properly accounted for as an asset, a PPEA would have needed to embody an incremental claim on cash. For this to be true, the PPEAs would have had to give the participating accounts access to a benefit, namely the merger synergies, that they would not already have had access to.
However, the CFO of GWL acknowledged that expense savings from the merger synergies would have flowed to the participating accounts with or without a contribution to the acquisition price. The only way to have prevented this natural flow would have been for the defendants to change their statutorily-approved allocation methods prior to the acquisition. This would have required disclosure and presumably negotiations with the benefit of independent legal, actuarial and accounting advice for the participating policyholders. The Court concluded that this would have been the best course of action for the defendants to have taken.
As a consequence, the Court concluded that the defendants had no legally justifiable method of depriving the participating accounts of the benefit of the merger synergies. It followed that the shareholder accounts were not in a position to “sell” that benefit to the participating accounts through the PPEAs, and so the PPEAs were not properly assets under GAAP. By treating them as such in their financial statements, the defendants had breached section 331(4).
The Court also found a third breach of the ICA by the defendants under section 458. Section 458 sets out limitations on the manner in which expenses may be allocated to participating accounts. With regard to the PATs, the expense at issue was the amortization of the PPEAs in the participating accounts over 25 years. Drawing on its discussion of the breach under section 331(4), the Court concluded that because the PPEAs are themselves unlawful assets, the amortization charges related to those assets must also be set aside. Accordingly, a breach of section 458 was found.
Under the second grouping of common issues, a number of allegations were made against the directors and officers of the defendants, including that they had breached their statutory duties of care and fiduciary obligations. The directors and officers successfully defended these claims by relying on the business judgment rule and the “safe harbour” provision of the ICA, which entitles directors and officers to rely in good faith on the reports and advice of professional advisors.11
Nevertheless, citing section 166(2), the Court concluded that the fiduciary obligations of the directors and officers require at a minimum that the corporation complies with its statutory obligations. The Court also noted that the directors and officers could not excuse themselves by relying on OSFI, as the responsibility for the company ultimately rested with them, not the regulatory body. Finally, the Court found that the business judgment rule provides no defence in the context of a statutory breach, and so because of the defendants' violations of section 462, 331(4) and 458, the directors and officers of those defendants were found to have breached section 166(2).
As the defendants' breaches all related to the illegitimate transfer of surplus funds out of the GWL and LL participating accounts, the Court found that the most appropriate remedy was to order the return of the $220 million to those accounts effective November 1997. To achieve this result, the Court also ordered that the GWL and LL participating accounts be awarded an additional sum of $172.7 million, plus a $63 million gross up for taxes, to replace the return on investment that the participating accounts would have earned after November 1997 if the PATs had never occurred.12
The Court also ordered that the amortization of the PPEAs should be terminated as of January 1, 2011. The Court did not make this order retroactive to November 1997 as doing so could result in a windfall to the participating accounts in addition to the $172.7 million in foregone investment income awarded.
Common issues trials are rare under the CPA. However, this case shows that allegations of non-compliance with a statutory regime may be well suited to such a trial. In such cases, there may not be any significant individual issues at play. As a consequence, by determining whether or not the relevant statutory provisions have been breached, the trial may be able to resolve the outstanding disputes.
Still, it will only be in exceptional cases that a common issues trial will lead so directly to damages. In this case, while the class was composed of a large number of plaintiffs, those plaintiffs all suffered their alleged loses through two entities: the participating accounts of LL and GWL. As a result, to remedy the defendants' breaches, rather than examining the circumstances of each individual plaintiff, the Court was simply able to make the participating accounts whole.
Another important message from the case is that the value of a regulatory body's approval will depend on the process through which that approval is achieved. In this proceeding, the Court made clear that it will not defer to a regulator that has failed to properly investigate the relevant issues on its own behalf. Reliance on an interested party's review of the matters in question, even where that review is independent, will endanger any possibility of deference by the court to the decision of the regulatory body.
The converse, however, is also likely to hold true. If OSFI had undertaken an independent and fulsome investigation of the proposed acquisition, in particular assessing the legality of the PATs, and had nonetheless granted its approval, the Court would have been hard-pressed to dismiss OSFI's conclusions. As a result, a party intending to rely on the decision of a regulatory body should ensure that it familiarizes itself with the extent of the regulator's own review of the relevant issues. If that review has not been thorough, the party relies on the resulting decision at its own peril.
As a corollary to this issue, it is of note that an OSFI representative was permitted to testify at the common issues trial. OSFI's representatives were summoned by both the plaintiffs and the defendants. However, in the midst of the hearing of the trial, OSFI attempted to quash the summonses of its representatives on the grounds of deliberative secrecy.13 The principle of deliberative secrecy applies whenever evidence is sought about how or why an administrative tribunal reached a particular decision.14 The purpose of deliberative secrecy is to preserve the independence of decision makers, to promote consistency and finality of decisions and to prevent decision makers from spending more time in court testifying about their decisions than actually making them.15 However, the principle only applies with regard to the mental process of the administrative tribunal and to the adjudicator's thoughts on the relevant issues; it does not apply to the formal process followed by the administrative tribunal to reach its decision.16
Accordingly, the common issues trial judge concluded that the OSFI representative could testify as to whether, in recommending the approval of the overall transaction, OSFI had considered whether the PATs complied with the ICA. The trial judge's decision on the issue of deliberative secrecy was appealed to the Ontario Court of Appeal mid-trial. Though the Court of Appeal upheld the trial judge's ultimate conclusion, it sought to clarify the justification for that conclusion.17 Specifically, it held that questions regarding the extent to which OSFI reviewed the PATs are questions of fact, and so beyond the scope of deliberative secrecy.18
As such, in deciding whether to defer to the decision of a regulatory body, a court may look at the formal process the adjudicator followed in reaching its decision. Though the court will not be able to look into the “mental process” of the regulatory body due to the principle of deliberative secrecy, it will nonetheless be afforded a certain latitude to explore the extent of the regulatory body's review of the matters in question.
Finally, it is of significant importance that, as discussed above, the Court found a breach of section 166(2) notwithstanding that the directors and officers of the defendants relied upon the Report in approving the acquisition. This breach was entirely dependent on the defendants' breaches of sections 462, 331(4) and 458 of the ICA, as the Court found that the business judgment rule provides directors and officers with no protection in the case of a statutory breach.
In this case, this conclusion was of little practical importance: the Court had already found that the defendants had breached three provisions of the ICA, and given that the directors and officers were not named as defendants, no damage award was made against them personally, and the breach of section 166(2) did not give rise to any further liability.
Nevertheless, the possible implications of the Court's decision are troubling. Specifically, while the Court addressed the validity of the business judgment rule in relation to section 166(2), it did not consider the “safe harbour” provision under section 220 of the ICA.19 Section 220(1) provides, among other things, that a director, officer or employee has fulfilled their duty under subsection 166(2) if they exercised the care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances, including reliance in good faith on a report of a person whose profession lends credibility to a statement made by them.
By failing to consider this provision, and instead concluding that the defendants' breaches of the ICA inevitably led to a breach of section 166(2) by the directors and officers of the defendants, the Court appears to have indicated that a statutory breach trumps any attempts at due diligence by a director or officer. Such an interpretation would be in contradiction to a plain reading of the ICA, and comparable provisions in the corporate law statutes. More importantly, if directors and officers were held to be in breach of section 166(2) every time their companies breached some other provision of the ICA, with no way to avoid this result by exercising due diligence, directors and officers could be subject to significant indeterminate liability.
This will therefore be an important issue that directors and officers, and particularly officers and directors of insurance companies governed by the ICA, will want to follow on the appeal of this case.